Bankruptcy Often the Least Desireable Option to Eliminate Student Lo...

I recently received this email from a prospective client (“Jane”) seeking to have her student loans discharged in bankruptcy.  Do you see the problems with this case?

I am permanently disabled due to cognitive decline resulting from a craniotomy to repair one of three aneurysms. I also suffer from back pain, anxiety, depression and panic attacks. In addition to my 2012 brain and gallbladder surgeries, I underwent back surgery in 2011 and two foot surgeries in 2010, and due to complications from my back surgery I have not been able to return to work. . I was very recently approved for disability retirement after 25 years as an employee with the federal government.  I also receive SSI.   I filed a chapter 7 in 2008 and am unsure what my options are in regard to having my student loans forgiven. I am seeking a full discharge.

Let’s start with the most immediate problem – currently, Jane’s eligibility to file bankruptcy.  Under Bankruptcy Code Section 727(a)(8), Jane is not eligible to file Chapter 7 for eight years after previously filing a Chapter 7 1.  Depending on when in 2008 she filed, she would have to wait until at least 2016 before filing a second case.

Assuming for sake of argument that Jane was eligible to file Chapter 7, a practical problem she would face using bankruptcy to discharge her student loans would be that of cost.  Bankruptcy Code Section 523(a)(8) says that student loans are not dischargeable in bankruptcy unless the debtor can show that not discharging them would constitute undue hardship.

In defining undue hardship, bankruptcy judges have come to rely on an analysis set out in a 2nd Circuit case called Brunner vs. New York State Higher Education Services Corp.  The Brunner test considers three factors to determine whether student loans can be discharged in bankruptcy:

1. has the debtor made a good faith effort to repay his loans
2. based on current income and expenses, can the debtor maintain for himself and his family a minimal standard of living if forced to pay his loans; and
3. are the debtor’s financial circumstances likely to remain during a significant portion of the student loan repayment period

Based on what Jane writes, I think she would have a reasonable argument that she meets all three elements of the Brunner test, although in general bankruptcy judges have been reluctant to discharge student loans.  Regardless, Jane would have the burden of filing a lawsuit in bankruptcy court to put the discharge issue before the judge.  Bankruptcy litigation is not cheap – it is likely that the cost of this type of litigation could reach $5,000.

I think that there are better options than bankruptcy for Jane.

First, she has the option of doing nothing.  If Jane’s only source of income is SSI and she has no assets, she is essentially judgment proof.  SSI (which is the welfare type of disability) may not be garnished by anyone, even the Department of Education.  Jane may end up with judgments filed against her but those judgments are uncollectible and will remain so unless her life circumstances change dramatically.

Second, if Jane’s student loans are federally issued or federally guaranteed, she can apply for loan forgiveness based on disability 2.  The Department of Education has recently changed its rules regarding disability forgiveness and Jane’s SSI disability determination may be enough to convince the government to forgive her loans.

Third, if Jane’s loans are federally issued or guaranteed, she could enter an income based repayment plan.  Assuming her income remains low, the income based repayment plan formula would likely call for a zero dollar payment.  At the end of the repayment term (usually 20 years), the loans would be deemed satisfied and Jane’s liability would end.

So, Jane has a variety of options and based on the information at hand bankruptcy would be the least desireable.

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